When The Tide Went Out: 1992

by puneinvestor

The BSE Sensex went from 1000 in 1991 to 4500 at its peak in 1992 and back down to 2500 at the end of 1992. For people who got in at the start and stayed with solid companies, their investments remained profitable even after the crash of 1992. But many punters were found shirtless in the aftermath of the Harshad Mehta scam. Worse, innocent tax payers who were far removed from the stock market lost more than Rs. 20,000 crores (inflation-adjusted) because of the fraud committed at the expense of state-owned banks. Only five or six thousand crores of this money has been recovered. There is now, 22 years later, no chance that the rest of the money will be recovered.

The Sensex took a 600-point (roughly 13%) hit immediately after the day the scam was first reported and continued its downward trend for a while. A good analysis of the events and impacts of the scam is in Barua and Varma’s article in a 1993 issue of Vikalpa. In short, Mehta became an unofficial broker in the government securities market and siphoned off client money fraudulently to fund his and others’ speculation in the stock market. With the amount of money he was able to divert, he could move the prices of the most blue-chip scrips in the country. They called him the Big Bull.

There were two important factors which were conducive to the events that took place. One was the temptation for the state-owned banks to reach for extra yield amidst heightened competitive pressures and the other was the exaggerated differential in interest rates between the government securities market and the equity market, which was funded by the informal badla system. Mehta was able to exploit a sweet spot at the junction of these market forces and created a network of corrupt bank officials, greedy brokers, gullible investors and, allegedly, monied politicians. Lording over this unholy nexus were clueless regulators. When the lid was blown off the scam, it turned out that Harshad Mehta wasn’t the only one making hay. There were other entities taking advantage of the immature financial system. Mehta was singled out for fame or infamy, I think, because his was a rags to riches story and he was a flamboyant character.

When stock market speculators get easy access to funds, borrowed or stolen, it’s a recipe for disaster. Early successes fuel further excesses but eventually the music must stop. When it did in April 1992, the market crashed and did not recover until seven years later in 1999.

The takeaways from 1992 are many. Investors who were taken in by the hype of the markets, as usual, suffered. The interests of officials in state-owned banks are (sometimes through illegal arrangements) very different from the owners of the banks, i.e. the people of India. Financial market regulations in 1992 were disjointed, lightly enforced and inadvertently encouraging of “accepted practices” (nothing but short-cuts) which were exploited by the rogues. India has failed to recover the losses from the scam in any meaningful way. The reasons for this, including bureaucratic inefficiencies, political influences and judicial delays, are well beyond the scope of this article.

The most important takeaway for the long-term, buy-and-hold investor is that the famous crash of 1992 would scarcely have impacted him if his money had been invested in high-quality companies at attractive prices in 1991.

And finally, some people attribute accelerated equity market reforms in India to the crash of 1992. If that is true then perhaps some good did come out of all this.